January 15, 2023

Inflation Deflates while Earnings Inflate… To Date!

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Bottom Line:


Last week’s cooler-than-expected wage report led to spirited stock purchases, while this week’s cooler-than-expected consumer price inflation report led to more. Unfortunately, disinflationary trends provide companies with less pricing power, lower revenues, and, therefore, earnings compression. Bearish analysts have factored the undertow of disinflation and potential recession into their gloomy earnings projections for 2023. So, while lower inflation may bring cheers among investors, lower resultant earnings would quickly flip the script. Analysts expect S&P 500 earnings to decline for the just-completed quarter. So far, with only a fraction of companies reporting, they are wrong. Should earnings grow in Q4 rather than shrink, a whiff of 2023 optimism could propel markets considerably higher… likely what’s behind its 4% advance so far.



The Full Story:


Markets continued to punish the pessimists this week with the S&P 500 now over 4% higher in 2023. Last Friday’s wage disinflation report helped set the trajectory, while this week’s CPI report and better-than-expected earnings from the major banks helped maintain our course. Throughout the year, markets will fixate on the interplay between inflation and earnings. Remember, inflation actually boosts corporate earnings as higher prices drive higher revenues. When inflation falls, revenues fall, leading to corresponding compressions in earnings and, ultimately, stock prices. Analysts calling for disinflation and recession have marked down corporate earnings considerably. We are more optimistic, as corporate executives have had months to prepare for recessionary threats. Proposing that even in light of inflation and a potential recession, earnings resilience could surprise to the upside. This week provided two main data points to help resolve our dispute.


The Consumer Price Index Plunge


The U.S. Bureau of Labor Statistics released its December CPI report on Thursday morning. For the month of December, Consumer Price Inflation fell .1% versus November while gaining 6.5% over the past year. This stands well below the 9% reached in June but still well above the Fed’s 2% target. However, a deeper dig into the report reveals more weakness than the headlines might suggest. Consider the following 3-month average across the goods, services, and shelter components:



My project



Core goods prices have slipped into deflation as new and used auto prices have collapsed, with auto semiconductors more prevalent and logistics bottlenecks cleared. Services excluding shelter inflation have legged lower as COVID revenge travel and dine-outs moderate. Only rent inflation remains truly problematic, but of all the indicators, this lags the most. In fact, if we look at more concurrent indicators like the New Tenant Rent Index and the All Tenant Repeat Rent Index, we find rapid disinflation in rents that will ultimately register in CPI:


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In sum, with goods inflation deflating, services ex-rents inflation dis-inflating, and rent poised to fall based upon more current indicators, inflation has clearly committed to a downward trend. Inflation gains over the last three months, annualized at closer to 3%, get us pretty close.


4th Quarter Earnings Yearnings


Earnings season began in earnest on Friday as the major money center banks released their fourth-quarter results. Analysts project S&P 500 earnings to fall 4%, the first quarterly decline since 2020. Only a small portion of the S&P 500 has reported results to date, but so far, the results have proven promising. Of the 29 companies that have reported, 79% have beaten estimates by 7.7%, on average. Should S&P 500 companies grow earnings in the fourth quarter rather than shrink them despite inflation declines, investors may see this as positive foreshadowing for 2023. If so, earnings resiliency spells investment opportunity, which will recalibrate expectations and rerating indices higher.


Have a great Sunday!


David S. Waddell  

CEO, Chief Investment Strategist




Sources:  BLS, FRED Database, Bloomberg



David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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